Are capital markets taking a wrong turn? Soul-searching on short-termism after UK’s Kay Review

Lots of useful commentary is published this week about what’s going wrong with the world’s leading capital markets and finance. This new bout of soul-searching follows the publication of Prof John Kay’s “The Kay Review of UK Equity Markets and Long-Term Decision Making” on 23 July and available here (and the Interim Report, published in February, with much of the evidence is available here.
The Prof says that equity markets are not working as effectively as they could. “We conclude that short-termism is a problem in UK equity markets, and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain”. He says that successful financial intermediation depends on: “Trust and confidence are the product of long-term commercial and personal relationships: trust and confidence are not generally created by trading between anonymous agents attempting to make short term gains at each other’s expense.”
He blames the prevailing culture and says that people don’t only work for financial incentives, as widely promoted in current City culture – “Most people have more complex goals, but they generally behave in line with the values and aspirations of the environment in which they find themselves.” Prof Kay puts forward a series of 17 recommendations on how to make things better and this could be useful reading for anyone involved in developing capital markets with an aiming to help grow savings and create better performing businesses. This includes fiduciary standards of care if you manage other peoples’ money, diminishing the current role of trading and transactional cultures, high-level statements of good practice, improving the interactions of asset managers and other investors with investee companies, and tackling misaligned incentives in remuneration, and reducing pressures for short-term decision making. The Guardian newspaper’s Nils Pratley has a useful summary of some of the best recommendations here, ironically coupled with a beautiful rosy photograph of the City!
One background comment is by Evening Standard columnist Anthony Hilton here. He says “The behaviours that led Deputy Governor of the Bank of England Paul Tucker to use the word “cesspool” when giving evidence to the Treasury Select Committee on Libor come in a straight line from the reforms imposed on the Stock Exchange by the then Prime Minister Margaret Thatcher in 1986 when she forced it to open up membership to all comers, and in particular to abolish single capacity — the arrangement under which firms had to confine themselves to a single activity in which they acted for themselves or for the client, but not both… From being a servant of the real economy, finance began its journey towards becoming an end in itself, with deals done not because they had economic rationale but because they made money for bankers and costs, both direct and indirect, that impose a colossal and unnecessary burden on that real economy.” He adds that this kept the system honest “or rather it was dishonest in a less poisonous way. Until Big Bang, the problems came from dishonest people working in honest firms; today the problems are caused by honest people working in dishonest firms. The culture is rotten.” This brought world-beating businesses low “by policies designed to pander to the stock market rather than secure the businesses’ long-term future for its customers, employees and indeed the country.” He says the rewards of finance should belong to customers, not their advisers.
Kay also notes that index investing, as growing popular in some African markets with the rise of ETF (exchange-traded funds) and other derivatives, may not represent a strategy for representative returns, see this Financial Times summary. He also urges less securities lending.
Most of the leading commentators though conclude that the view is rather rose-tinted, and not in touch with the real world. The Financial Times Lex Column says (unfortunately this link may be subscribers only, but you did not miss much if you don’t find a way around): “Dig a little deeper though and this vision – which includes an attack on the efficient markets hypothesis – is flawed”. It says although investors should engage more with companies a falling share price is better incentive for a manager to perform well than a phonecall and that quarterly reporting helps people see what’s going on and reduces insider trading. It points to the UK’s “shareholder spring” in which investors forced change at companies such as Aviva and AstraZeneca. Another Financial Times summary of reaction is that Kay is “no silver bullet” and while people may agree with his views “some.. may prove challenging to implement in practice”. Some recommendations can be implemented by the industry, including investors’ forums for collective long-term engagement and good stewardship, others such as calls for asset managers to disclose all costs, including transaction costs and performance fees charged to funds, may be carried out voluntarily. Only a few may be carried out through legislation, and many others (apart from Lex) support removal of obligations for quarterly reporting and argue that managers’ time could be better spent elsewhere.
It’s a week of interesting reading for people, including many in Africa, building capital markets that are meant to serve economies, the creation of business growth and jobs, and also to encourage more long-term savings.
Discussion is very welcome!

3 Responses to “Are capital markets taking a wrong turn? Soul-searching on short-termism after UK’s Kay Review”


  1. Thanks for great post

    Thanks for great post…

    […]Are capital markets taking a wrong turn? Soul-searching on short-termism after UK’s Kay Review | African Capital Markets News[…]…

  2. Tom Minney

    Shane, the feedback is much appreciated. Thank-you

  3. Rachel Kasumba

    Tom, thanks for updates. For the last couple of years, investors and general public around the globe are alarmed at revellations of fund mismanagement via insider trading, short-termism,etc in developed economies, all aimed mainly at gaming the stock markets for massive personal profits of the brokers and other players at the expense of investors/shareholders.

    If these practices continue unabated, the markets are bound to collapse completely especially in emerging markets, that usually suffer from poor governance, weak regulatatory frameworks, staff expertise and exposure to more complex products is sometimes limited, especially in the new markets, unreliable infrasture that still relies on paper/manual trading and the like.

    While Kay’s review and recommendations may not be the silver bullet, it is at least a starting point and some of them need to be implemented asap if we are to move forward especially regaining investor confidence in the world markets as the problems discussed above are not unique to the UK equity markets only.